From the Federal Reserve Bank of Minneapolis' The Region:
Interview with Michael WoodfordPreviously on the Woodford channel:
Columbia University economist on Fed mandates, effective forward guidance and cognitive limits in human decision making
Interview conducted July 23, 2014Though pundits suggested otherwise, there was no straight-line causality from Michael Woodford’s presentation at the Fed’s August 2012 Jackson Hole conference to the FOMC’s December 2012 adoption of inflation and unemployment thresholds. While both involved “forward guidance” and stressed clear communication about a credible policy path, the timing was doubtless coincidental.
But there is also little question that Fed leaders were already well-steeped in Woodford theory, and quite familiar with the arguments he made in August. For nearly two decades, the New Keynesian model*—of which Woodford is a leading architect—has been a key framework for academic research in monetary economics, and bedrock for research and policymaking at central banks worldwide.
With this framework, Woodford and his co-authors have explored and explained the mechanisms by which monetary policy affects employment and production, as well as interest rates and prices, and because his work has such practical utility and intellectual power, the way policymakers think about policy—and arguably, design it—has shifted fundamentally. His insights into policymaking when nominal interest rates can go no lower have been particularly useful.
Woodford’s 2003 Interest and Prices—called a “bible for central banks” by some economists—discussed these ideas at length. “Immensely influential,” said Princeton economist Lars E. O. Svensson of the book, in awarding the 2007 Deutsche Bank Prize to Woodford for establishing “foundations for … models now being developed by the most advanced central banks [and] also providing central bankers with a practical framework [for thinking about] monetary policy, in particular the fundamental role of expectations and transparency.”
The Deutsche Bank award is one of many Woodford has received. While still a graduate student at MIT, he was selected by the MacArthur Foundation for its inaugural class of “geniuses” in 1981. He’s been recognized with fellowships from the Guggenheim Foundation, Econometric Society and American Academy of Arts and Sciences, and awards from numerous other institutions.
Woodford’s intellectual interests are unusually broad. He went to the University of Chicago initially to study physics, then majored in cognitive science, got a law degree at Yale and later chose economics—drawn by both its theoretical rigor and concrete application. “Central banking,” he observes, “is one of the human activities where I think there is some real use to relatively abstract theoretical contributions.”
* Developed in response to the potent 1970s rational expectations/flexible prices critique of then-dominant Keynesian theory and policy, the New Keynesian model accepted some of the critique but argued that rigidities in pricing caused markets to adjust slowly and could result in undesirable fluctuations in employment and production. Stimulative fiscal and monetary policy—if well-designed and implemented—could therefore be effective in counteracting economic downturns.
EFFECTIVE MONETARY POLICY
Region: I’d like to start with some questions about policy, in particular, forward guidance. In August 2012 at the Fed’s Jackson Hole symposium, you gave a very influential speech in which you compared two options for monetary policy when at the zero interest rate bound: forward guidance and quantitative easing (balance sheet) policies.
You argued that essentially both theory and data suggest that forward guidance is likely to be the more effective of the two, and you further recommended that policymakers should make “advance commitment to definite criteria for future policy decisions.”
Four months later, at the December Federal Open Market Committee meeting, the Fed did adopt forward guidance—in the form of thresholds for unemployment and inflation—along with continued quantitative easing. Did that approach meet the standards you would advocate in terms of definite criteria?
Woodford: It was certainly a step in that direction. Not only was it an attempt to shape expectations by making official statements about future policy, but it was in line with what I had been arguing for in at least one important respect, which is that it was saying something about criteria for making a future decision as opposed to trying to announce the future policy settings themselves in advance.
The Fed had already been using statements about future policy as an important part of its efforts to stimulate the economy, particularly dramatically since the previous summer, when it had begun making quite unprecedented statements about specific dates, as far as two years in the future, until which the FOMC anticipated being able to maintain its current unusually accommodative policy. But that approach didn’t involve stating criteria for making a future decision; instead, it only offered a guess about where the federal funds rate would be at specific future dates.
There are various reasons why I think such “date-based guidance” is a less satisfactory way to try to shape expectations about future policy. The most important problem is that it’s unlikely that a central bank would really be making a promise or declaring an intention about future policy and make it in this very specific form of saying where the instrument will be two years in the future.
And, of course, the FOMC wasn’t really making such a promise. If you looked at the fine print of what they said, they hadn’t said we intend to do this. They hadn’t said we will do this. They had said we currently anticipate that future conditions will warrant our doing it....MORE
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